DOES IT PAY TO WORK MORE?

April 15, 2008

Does it pay to work more hours in order to earn more income? The answer depends on what one earns after taxes. Virtually all American households are confronted with high to very high marginal tax rates when they increase the number of hours they work in the current year or in future years. Much of the system's highest effective marginal taxation comes courtesy of government transfer programs, particularly Medicaid. In fact, penalties for working are astronomical for some households, particularly lower-income families, say Laurence J. Kotlikoff, a professor of economics, and David S. Rapson, a doctoral candidate, both of Boston University.

The fiscal tax system is regressive:

For 30-year-old couples earning $20,000 a year, the marginal tax rate on an additional dollar earned is 42.5 percent; yet those earning $50,000 a year face a marginal tax rate of only 24.4 percent.

At age 45, couples earning $30,000 a year face a higher marginal tax rate (41.9 percent) than do those earning $200,000 a year (35.9 percent).

At age 60, couples earning $10,000 a year faces a marginal tax rate of 50.9 percent, compared to a 43.2 percent marginal tax rate for those earning $200,000!

Moreover, single-parent households who qualify for more benefit programs than do couples face astonishingly high marginal tax rates beginning at lower incomes. For example:

At age 30, a single parent earning $10,000 a year faces a 72.3 percent marginal tax rate on an additional dollar earned due to their loss of welfare benefits; this rate is substantially higher than the 36.9 percent tax rate on the single parent earning $200,000.

At 45 years of age, a single parent earning $20,000 faces a marginal tax rate of 42.9 percent; higher than a single parent earning $200,000.

A 60-year-old single parent earning $10,000 a year faces a 50.9 percent marginal tax rate, while those earning $200,000 face a rate of 43.2 percent.

Source: Laurence J. Kotlikoff and David S. Rapson, "Does it Pay to Work More?" National Center for Policy Analysis, Policy Report No. 310, April 2008.